How does a high level of non-performing loans affect banks?

A high level of non-performing loans significantly weakens the balance sheets of banks and often leads to stricter lending practices. Non-performing loans are loans on which the borrower is not making interest payments or repaying any principal, which means that banks may not receive the anticipated cash flow from these loans.

When a significant number of loans become non-performing, banks must set aside more capital reserves to cover potential losses. This creates a strain on their financial position, reducing the overall strength of their balance sheets. A weakened balance sheet can hinder a bank's ability to lend, as the bank needs to maintain certain capital ratios to meet regulatory requirements and ensure financial stability.

The presence of high non-performing loans also influences banks to adopt stricter lending criteria to mitigate future risks. This often results in more cautious assessments of borrowers, potentially leading to a decline in loan approvals and tighter credit conditions in the broader economy. In essence, the repercussions of non-performing loans require banks to reassess their risk management strategies and enforce stricter lending practices to protect themselves from further losses.